Markets are looking pretty ugly this morning, with Europe coming off a nasty 5% down day.

Whenever we see this happen, humans engage in a panicky reactive approach regarding their investable assets.

As I have suggested all toomanytimes, you should have a proactive approach that recognizes the reality of these all too regular hiccups, and plans accordingly. You also need discipline to follow your plan, and the ability to handle your own emotional turmoil.

Both are much easier said than done.

For the typical investor, I have long suggested the following Investment philosophy: If you are an individual managing your own portfolio, as a general rule, I favor dollar cost indexing on a monthly basis. For most people of reasonable means, this is the lowest risk, highest return approach. No stock selection, no market timing, nothing exotic. I also advocate layering a risk management approach on top of that, even if its something as simple as using a 10 month moving average as a sell signal.

But the above pretty much sums up your three options. To grossly oversimplify, in equity markets you can have as your goal:

1. Market Performance

2. Market Performance with less Risk

3. Market Out-Performance

There is also the widely enacted but little discussed failure to achieve the above, a little something called Market Under-Performance. Far too many over-active traders engage in some version of that. Even the better traders tend to forget about friction — costs, commissions, fees, taxes — that makes beating markets so challenging.

As I am fond of saying, the time to grab that card from the seatback in front of you, look where the emergency exits are, where oxygen masks are located, and whether your seat is a flotation device is when you are on the ground and the stewardess is giving her spiel. At 30,000 feet with the engines on fire and the wings coming off, it is likely to late to think about emergency exits.

Which brings us to today’s session. Regardless of the woes in Europe, a probable US recession, a possible QE3, the 2012 Presidential election, the next Quarters profits, amidst the endless idiotic blather coming out of your TV, you should be doing nothing more than executing your well thought and intelligent plan. (You do have a plan, don’t you?)

As previouslynotedlastmonth, I am sitting in 50% bonds and cash, the rest in high quality dividend paying equities with a cherry of gold on top. I can comfortably wait for stocks to get cheap enough to buy, whether that turns out to be at SPX 1050 or 750. I am not looking to bottom tick the market; rather, we want to buy good asset classes at reasonable valuations. This means that over the long term, clients get good returns in light of whatever risk they assume.

None of this is rocket science. Rather, it is about understanding the regular market dislocations, the full economic cycle and human psychology. This also means understanding your own predilection to occasionally overreact.

Panic tends to lead investors to make bad decisions at the worst time. But it also means you are doing something wrong. Figure out what that error is – and then fix it.

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

Sometimes it’s a hiccup, sometimes it’s a heart attack. At 30,000 feet, knowing where the exits are won’t help (even on the tarmac, a plane engulfed in flames will make getting to the exits fairly difficult, if not impossible).

I don’t know if we are on the threshold of a cataclysmic event, or if we’re experiencing unusually rough, but manageable, turbulence. I do know that when the real trouble starts, the best laid contingency plans will not necessarily save your ass.

Essentially, common sense investing approach. The devil is in the details though, as those dividend paying equities, and exactly what bonds, that are being held. For that, it’s not common sense; it’s being a good stock picker. This thing can be vicious, and 401k investors have neither the skill or patience to outperform. They will underperform most of the time.

I’d recommend against index funds, many of which buy more of a stock when its overvalued, and vice versa.

And the gold cherry should be called the superstition give away. Talk about friction, this is the ultimate unnecessary cost. Mauldin calls gold insurance, but this is patently ridiculous. Gold is backed by nothing other than tradition — not by intrinsic value (which is much lower than its current price), not by governments…

A tradition that is shared by all cultures for all of recorded history. That gold is backed by nothing is correct. What would back it? Fiat dollars? A dwindling supply of oil? If gold has an intrinsic value, or not, is debatable. The bottom line value of gold is apparent when one realizes that central banks and nations hoard it.

But, to check my inference from your advice, if one happens to be invested, and happens not to have developed a plan for a day like this, the best thing to do today is something other than ‘making adjustments’ to the investment portfolio’…. right? Like, a few days after burying your spouse is not the best time to decide to put the house on the market and move in with the kids….

“You also need discipline to follow your plan, and the ability to handle your own emotional turmoil.”

I am a small-time investor ($100,000) since 1998. I started as a long term “buy and hold” guy but am now working on learning trading styles etc since it appears that the long-term is getting shorter.

I have been looking back at my “buys and sells history” and have found that I do not have the discipline to be “disciplined ” when it comes to the SELLING aspect of Risk Management. Thus, I have concluded that the simplest way to solve this serious weakness is to give this part of the TRADE to my son and I will focus on the those things that my back-testing has shown I am good at.

It is interesting what this process of learning to “know oneself” with respect to my Investment/Trading Plans has shown me. In looking at my problem of not being able to “pull the trigger” when the PLAN says to do it I have finally seen why I have the problem. Before retiring, the last 30 years of my working career were spent as a high school teacher/department head/football and basketball coach in Canada. In each of these areas I was a very good planner and organizer and had success but I had GREAT difficulty when it came to those aspects of the job like: Does Dick and/or Jane FAIL?… Do I FIRE Ms. Brown?…Do I CUT Andy after tryouts. I found many ways to circumvent making those decisions, the most costly from a financial point of view was actually resigning my position as Department Head.

Thanks to you Barry for having this blog. While you are not the only one who preaches on the necessity of the Plan and the required discipline to follow it you do it in such a way that it makes one pay attention to the message.

So in summary,” What have you helped me learn?” Firstly, I am great at selling well after the time my plan said I should have sold so I can feel good about myself because I have found that I am just not great at it I am almost perfect at it. Secondly, if my son does follow the Plan and sells something and it turns out that it went back up I can call him and use one oy your favourite expressions…. WTF. (LOL)

My strategy has been to refuse to buy the least ugly of the dogs, just because the dog is the least ugly. The least ugly dog is still ugly. Cash is a perfectly acceptable position.

If stocks go down to more reasonable valuations, I’ll buy some cash rich, little debt high dividend companies. But 16 P/E for consumer staples like PG and JNJ in a little/no/negative growth environment does not carry a large margin of safety. And don’t get me started on the AMZNs of the world.

@Concerned Neighbor – both PG and JNJ are trading below the P/Es you mention and have dividend yields in the mid 3% range with cash flows that are sufficient to cover the dividend. Sure you have some principal risk but only if you sell the stock below what you pay for it. What is wrong if you just sit on it and collect the dividend? Are you going to make more in treasuries or even an FDIC insured account? If a company like PG goes south we’re in for a lot more trouble than folks expect and my old aphorism that you need a good tent, a rifle that shoots straight and a good hunting dog will come true.

@Orange14. It is the principal risk that is primarily of concern, but I also note the dividend coverage for both is ~50%. To make money on this stock I’d have to confident the price would not decline by the dividend yield, and that the dividend is secure at that amount. I’m reasonably confident of the latter, but definitely not of the former.

You list one of the ugly options out there (that is, treasuries). Just because a stock features a higher yield than the 2-year treasury doesn’t necessarily make it a good investment, especially when the treasury yield is artificially low due to Fed policy.

When I see the term “dollar cost averaging” I’m aware that it means something much simpler than one would expect from that impenetrable phrase, but I can never remember what it is. I’m sure it makes most people’s eyes glaze over.

If you advise averaging into stocks, remember that you also need to advise averaging out, and the periods for averaging in and averaging out both need to be 20+ years. So after 20 years of putting the same amount (adjusted for inflation) into stocks each month, start taking the same amount out each month, either to spend or to reinvest in short-term bonds or CDs. For example, move 1/(20*12-0) out of stocks the first month, then 1/(20*12-1) the second month and so on until the last month you take out 1/(20*12-239) or everything that remains.

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About Barry Ritholtz

Ritholtz has been observing capital markets with a critical eye for 20 years. With a background in math & sciences and a law school degree, he is not your typical Wall St. persona. He left Law for Finance, working as a trader, researcher and strategist before graduating to asset managementRead More...

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